John R. Moran on strategy and innovation

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For a long time, the answer has been “more.” Ever since Frederick W. Taylor did time studies of steelworkers with a stopwatch in 1900, the measurement of business activity – called “Greater Taylorism” by Walter Keichel in his business history “The Lords of Strategy” – has grown ever more central to management. One result of this drive to quantify and analyze has been that senior executives often create numerous profit centers, or isolated groupings of both revenues and expenses nested within large businesses.

The two benefits are obvious. First, profit centers allow these executives to make better decisions. In organizations whose various revenue and cost accounts are not linked, poor economic performance can be hidden by positive results elsewhere, and decision-making is clouded. Second, profit centers help make accountability clear. By giving managers direct profit and loss responsibility, companies can incentivize activity that measurably contributes to the bottom line.

So in most large companies, different business divisions and geographic regions are organized as distinct profit centers. Increasingly, product lines, key customer accounts, or brands are treated as mini-businesses as well, like at Procter & Gamble, where global brand managers have P&L responsibility. For that matter, why not functions too? Some organizations are establishing transfer prices for supplies and services between business departments (such as manufacturing and sales), and then measuring, and rewarding based on, the income of each.

There’s just one problem. We optimize what we measure. And the entire logic of profit centers rests on the assumption that maximizing the pieces will maximize the whole.

Unfortunately, this shortcut often isn’t true. Exceptional, sustainable results derive from great strategy, and great strategy isn’t additive – it relies on the way individual pieces fit together in a system, so that the whole is greater than the sum of the parts.

Decision scientists know this – in their models, it’s the difference between finding the local optima (the best result within each “neighborhood”) and the “global optimum” of the whole system. For that matter, football coaches know it too; no professional coach would argue that the best way to win a championship is to focus on maximizing each individual player’s performance statistics.

Yet this is exactly how many businesses are run. Rather than sacrificing certain parts for the good of the whole, companies essentially force each division to stand on its own. This approach undermines strategic fit, which, as Michael Porter put it, “requires the integration of decisions and actions across many independent subunits.”

For a coherent strategy to work, then, the organization executing it must be measured as a whole, rather than as parts. In other words, if a company is to have a single strategy, it must be driven by a single P&L.

This may sound like an extreme position. Yet some of the world’s most successful companies operate this way. Apple famously has only one P&L, for which its CFO, Peter Oppenheimer, has direct responsibility. And while each of its major hardware product lines is priced to make a significant profit, it bundles in all its key software upgrades, products, services, and platforms for free. CEO Tim Cook explains the logic:

“We manage the company at the top and just have one P&L, and don’t worry about the iCloud team making money and the Siri team making money. We want to have a great customer experience, and we think measuring all these things at that level would never achieve such a thing.”

It’s Apple’s single-company mindset that lets it give away industry-leading software and cannibalize its own products, which in turn has led to its unprecedented success. But that’s not to say a single P&L is always the right answer. Instead, a company should have as many P&Ls as it does distinct strategies. P&G’s Gillette shaving brand has a very different strategy from its Bounty paper towel brand, and Gillette has a different strategy in India than in North America. But although Gillette sells its razors and blade cartridges separately, these products fall under a single strategy. P&G’s profit centers reflect these boundaries.

Of course, companies should still measure a division, product, or function’s profitability (to the extent it can be done accurately) – that’s just good management. But this shouldn’t be the primary basis upon which managers are held accountable for their decisions, or they won’t enact a strategy that looks beyond their narrow interests. Amazon wouldn’t be able to underprice and over-market the Kindle to achieve their larger strategic objective of selling content if the Kindle product manager’s main objective was to maximize hardware profits. Nor would “free” look like such a great price point for Google’s Android unit.

So measure carefully – because if you reward each area of your business for acting in its own best interest, you just might get what you wish for.

Fifteen years ago, in perhaps the most important article on business strategy ever written, Michael Porter wrote that “the essence of strategy is choosing what not to do.” He drew a critical distinction: many decisions lead to unambiguous improvement, but real strategy – the key to lasting competitive advantage – requires trade-offs: choosing to focus on doing A well, even if that requires you to sacrifice B. Porter’s idea is neither complex nor new, but it’s still hard-learned.

Apple recently released a completely redesigned version of its advanced video-editing software, Final Cut Pro X. Amateur movie-makers such as the New York Times’ David Pogue praised its ease of use, but the reaction among professional video editors was scathing. Missing features and other changes were slammed. With regard to the negative feedback he got following his review, Pogue said he’d “never encountered anything quite like this.” The pro crowd was so incensed with what was termed Apple’s “failure,” “worst launch,” and “biggest mistake in years” that speculation quickly turned to what Apple could have been thinking. Some suspected that it intentionally stripped away critical features to “dumb down” its product and appeal to the much larger amateur editing market – a theory that only angered the pros further. Pogue himself emphatically argued that Apple didn’t intentionally turn its back on the professional market – instead, Apple just “blew it.”

Pogue is wrong. As Sachin Agarwal (founder of Posterous and a former Final Cut Pro product designer at Apple) put it, they knew the Final Cut Pro X redesign would be controversial. He described the rationale for their decision bluntly: “Apple doesn’t care about the pro space.” Nor does it compete on features – it “doesn’t play that game.” Instead, Apple took a professional-grade product down-market by making it simpler, cheaper, and more intuitive – and to do this, they changed and eliminated functionality.

What’s funny is that this has always been Apple’s strategy. While IBM made faster and more powerful PCs for the technical elite in the 1980s, the Macintosh had less RAM but introduced a mouse and graphical interface that any user could understand. More recently, many critics thought the iPad would be dead on arrival because of the features it lacked, but a few, such as John Gruber, understood that Apple was making a conscious trade-off – ignoring the feature-seekers and tinkerers in order to create the world’s most intuitive computer, cheap and capable enough for the mass market.

Did Apple have to choose? If it tried to design software or devices for both laymen and the elite technical segment, it would be forced to make a thousand subtle sacrifices to pull off the straddle – on features, UI, price, marketing, etc. In the end, it might still have made great products, but not as good as those it has now.

The risks of failing to choose are all too apparent when you consider some of the biggest disasters in the high-tech industry recently. There are eerie parallels between last week’s anonymous Research in Motion open letter to the CEOs (“instead of chasing feature parity … [t]here is a serious need to consolidate our focus…. Strategy is often in the things you decide not to do”) and Yahoo’s infamous 2006 leaked “peanut butter” memo (“We want to do everything and be everything – to everyone…. The result: a thin layer of investment spread across everything we do and thus we focus on nothing in particular…. We need to boldly and definitively declare what we are and what we are not”).

Contrast these with Steve Jobs’ philosophy on strategy, repeated endlessly over the years: “People think focus means saying yes to the thing you’ve got to focus on. But that’s not what it means at all. It means saying no to the hundred other good ideas that there are. You have to pick carefully … We’re always thinking about new markets we could enter, but it’s only by saying no that you can concentrate on the things that are really important.”

RIM’s share value is down ~33% over the last month. Yahoo’s is down ~60% over the last five years. By contrast, since Jobs returned to Apple, its share value is up almost 10,000%.

Michael Porter might say that the Final Cut Pro X debacle is exactly why Apple is the most successful company in the world.